Food for Thought

Food for Thought

05 Sep, 2012

Sarah Potter

The economy is always an issue in political elections. However, this particular upcoming election may be more driven by the economy than any other election, save for possibly 1932, in the midst of the Great Depression. No one needs to be reminded that these are troubling times, considering our low growth environment, weak housing market, our enormous federal debt burden, and a continuously high unemployment rate. All of this is being combined with the more time-sensitive issue of possible tax increases to come January 1, 2013, including the expiration of Bush’s tax cuts.

For Americans who are fed up with the financial state of things in our country, this is an extremely important election. While they may disagree on who is best to implement this change, all Americans are hopeful for a change in the direction of the economy, and they understand the significance of political leadership, especially for the economy.

On the topic of elections and the economy, there is a school of thought about the impact of election cycles on the markets. Obviously, there are countless factors that affect how the markets behave, but history shows that the election cycle and politics affect the markets. The following should merely be viewed as food for thought, or an anecdotal account of one way to summarize historical market performance, over a time period.

Known as Presidential Election Cycle Theory, the idea suggests that the stock market follows a general pattern, depending on the year (1st, 2nd, 3rd, 4th) of a president’s term. It specifies that the year immediately following an election is the worst for stock market performance in a Presidential Cycle. Performance improves the second year, and improves even further to be the best in the third year. Election years tend to be less strong for markets than the third year of an election cycle, but performance tends to be positive and generally very good. This could be tied to the vigilance, administrative action, and initiative that can almost always be relied on in the months leading up to elections.

To summarize Nickles’ results, he found that an investor who bought stocks and held them for approximately the first two years of presidential terms, then sold them at the end of the two year period experienced a negative return.

On the contrary, and in accordance with his theoretical conclusion, an investor who bought stocks and held them for the last two years of presidential terms, then sold them on the next inaugural day, would have earned more than 7,000 percent.

However, it is very important to remember all that this study is lacking. The study does not take into account active stock management. Also, in the current presidential election cycle, all four years have been positive. Finally, while the conclusions drawn for historical election cycles have been accurate, this does not mean anything with certainty for future elections. The markets are incredibly sensitive and responsive to so many other forces, especially these last few years in which fear and perception of market stability have been so important for investor behavior, and market performance, as a result. It should bode well, however, despite a very contentious election, for a positive return for 2012.